Federal payroll obligations imposed on employers can be expensive and time-consuming. Therefore, it is not uncommon for companies to outsource these responsibilities to third parties referred to as "third-party payers" (TPPs). Under a TPP arrangement, the TPP deducts, withholds, and remits employment taxes and prepares and files the corresponding employment tax returns on behalf of the employer.
Generally, these third-party arrangements work well for both sides. In exchange for offloading the payroll headaches to a third party for a fee, the employer has more time to focus its efforts and personnel on other better-suited activities outside of the payroll function. In addition, the employer usually has more confidence that its payroll obligations are being met because the TPP should, at least in theory, have more experience with payroll matters.
Recently, however, many employers who have filed employee retention credit (ERC) claims are learning of alternative headaches associated with their TPP agreements. Because the TPP uses its own employer identification number (EIN) and files the ERC claim on behalf of the employer through a TPP-filed employment tax return, many employers are left in the dark regarding the status of their ERC claims.
Federal Employment Taxes And Third-Party Payers
Under the federal employment tax laws, employers must deduct, withhold, and/or remit employment taxes. These taxes include Federal Insurance Contributions Act (FICA) taxes, income tax withholdings, and Federal Unemployment Tax Act (FUTA) taxes. In addition, employers must prepare and file employment tax returns, such as IRS Form 941, Employer's QUARTERLY Federal Tax Return (Form 941), and an annual IRS Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return.
Compliance with these payroll obligations can be onerous—particularly for smaller companies—resulting in the increased usage of TPPs. In addition to serving as the companies' payroll function, many TPPs also offer to manage human resources, employee benefits, workers compensation claims, and unemployment insurance claims. In general, the IRS recognizes the following types of TPPs: section 3504 agents, professional employer organizations (PEOs), and certified professional employer organizations (CPEOs).
To qualify as a section 3504 agent, the employer must file an IRS Form 2678, Employer / Payer Appointment of Agent, with the agency that designates a third party to act as the employer's agent for employment tax purposes. After the IRS accepts the designation, the section 3504 agent may file employment tax returns on behalf of the employer with the section 3504 agent's EIN. If the section 3504 agent has more than one employer client, the agent must also attach a Schedule R to the Form 941, allocating aggregate wages reported and credits claimed to each of the agent's clients. Although the section 3504 agent reports and pays employment taxes, the agent and the employer remain liable for underpayments of employment taxes.
The IRS also recognizes professional employer organizations or PEOs. Generally, these relationships are based on contract—i.e., a services agreement—under which the PEO agrees to assume responsibility to collect, report, and pay employment taxes associated with the employees at issue. Similar to a section 3504 agent, a PEO usually files an aggregate Form 941 under its EIN and, at least with respect to the ERC, must attach a Schedule R to allocate the aggregate wages and credits claimed for each of its clients. Employers and PEOs remain liable for any underpayments of employment tax unless the PEO is a CPEO. CPEOs must meet additional requirements and obtain certification from the IRS. The IRS maintains a publicly available list of CPEOs here.
The Problem
Given the arrangement between an employer and a TPP, questions can arise. For example, as related to the ERC, should the employer qualify for the ERC, and, if so, how should they claim it? The IRS answered these questions through administrative guidance, suggesting that employers who use TPPs may claim the ERC but that they should file for the ERC through their TPPs. See Notice 2021-20; Information Letter (9/29/22).
Because the IRS has been slow in processing ERC refunds, however, this ERC eligibility and filing dichotomy has caused some frustrations with employers looking to check on the status of their claims. As Frank Iannelli, a Managing Director of Whitley Penn in Fort Worth, Texas, explained to me, many of his ERC clients who used PEO arrangements are experiencing a lack of communication from the PEO. According to Mr. Iannelli: "Our clients are contacting us because they have no communication from the PEO regarding the status of their claim or when they should expect to receive it. This lack of communication has caused our clients to lose confidence that the PEO even filed a proper ERC claim."
Potential Solutions
Unfortunately, employers who fall within these circumstances don't have a lot of options. Under section 6103, the IRS can't speak to the employer in a TPP arrangement because the ERC claim filed by the TPP represents confidential taxpayer information. Although the employer may ask the TPP to execute an IRS Form 8821,Tax Information Authorization (Form 8821), which would allow the IRS to disclose information, many TPPs may be reluctant to sign the form. Tax professionals can help here in properly explaining the purpose and scope of the Form 8821 to the TPP, potentially alleviating any concerns.
Filing a lawsuit may also be an option. But whether an employer can maintain a lawsuit against the IRS in these third-party payer circumstances remains an open question (although the IRS has conceded that the ERC belongs to the employer). Those interested in this issue should follow a recently filed lawsuit in the United States District Court for the District of Maryland, which involves an employer seeking an ERC refund with the employer also using a PEO. See The Kenjya-Trusant Group v. United States, No. 1:24-cv-02592 (9/6/24).
Of course, maybe the best solution is the simplest one. As Mr. Iannelli mentioned in my discussions with him: "PEOs need to do a better job with their clients in informing them of what the process looks like and what the status of their clients' ERC claims are—this would alleviate anxiety and concerns." As a litigator, I would just add that such transparency between private parties may also avoid misunderstandings and potential lawsuits.
Conclusion
Given the IRS' perceived lack of transparency around the ERC program, it is disconcerting to learn that many TPPs also refuse to provide information to their clients regarding the status of their claims. To the extent practicable, eligible employers should continue to push for transparency with their TPPs. If all else fails, they should consult with their tax professionals to determine next steps, if any. In some cases, tax professionals may be able to bridge the gap between their client and the TPP.
Originally published by Forbes.com.
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